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Wisconsin’s fully funded, one-of-a-kind pension system surprises people, but not those who know the legendary thrift of Gary Gates.

While serving for two decades as the head of the state’s multibillion-dollar pension fund, Gates didn’t throw out dress shirts until he had cut off, reversed and resewn their frayed collars. He recycled tens of thousands of aluminum cans he had rummaged up in trash bins while biking to and from work — once even stopping on his way home from a meeting at the governor’s mansion.

Gates, 78, helped make the state’s pension plan a model for a nation of now-struggling systems. There’s just one problem: almost no one understands how Wisconsin’s system works.

“I’d be surprised if there were any (lawmakers here who do),” Gates said. “I would say there were probably only four or five from the entire time I was secretary who clearly understood the system.”

Looking at Illinois helps bring Wisconsin’s good fortune into focus. There, the state has set aside only 41 cents for every $1 that taxpayers owe in future pension payments — essentially tied for the worst level of funding in the nation.

Wisconsin’s fund serves 604,000 workers and retirees for the state and more than 1,400 local governments.

By one measure the Wisconsin system had a surplus of $2.5 billion as of December 2014, with relatively modest health care costs from allowing state retirees to buy into the state insurance system. At the end of 2014, the system of pensions in Illinois had a shortfall of $111.5 billion and that didn’t include the separate debts in the City of Chicago system or the massive retiree health care shortfall in Illinois.

The unfunded promises gap in Illinois state pensions alone is larger than Wisconsin’s entire pension system and more than enough to cover a full year of spending by the state of Illinois.

To fully fund their future pension promises, the residents of Illinois would have to devote the full value of all the goods and services they produce — what economists call the state’s gross domestic product — for nearly seven weeks.

Pensions in Illinois have long been among the most poorly funded in the nation, but going into the 2008 stock market crash, Illinois at least had 63 cents in assets set aside for every dollar that it owed retirees.

As the market crashed and state governments around the country faced financial pressures, the system in Illinois sank to catastrophic levels. Illinois is now in its second straight year without a full budget as Republican Gov. Bruce Rauner and the Democrat-controlled legislature wander in search of a lasting fiscal solution, leading to problems such as not paying bills of health care providers.

Dick Kratz, a retired corrections supervisor from Stoughton, doesn’t worry about his Wisconsin pension, knowing that it weathered the last market crisis well.

“It’s set up so it’s going to be nearly fully funded all the time,” Kratz said.

Sharing the risk

Wisconsin’s pension system includes elements of a 401(k), or defined contribution plan, in a way that no other state does.

“Wisconsin is unique as far as I know,” said Keith Brainard, research director for the National Association of State Retirement Administrators.

Wisconsin’s pension system, like most defined benefit plans in the country, guarantees qualifying workers a fixed minimum benefit based on their years of service and final salary at retirement.

But that’s not the whole story.

A Wisconsin retiree’s pension benefits can rise above the minimum level and also fall back down to that minimum if the plan’s investments underperform or if the cost of the benefits comes in higher than anticipated — for instance if pensioners end up living longer than expected. This approach is called a “shared risk” model, referring to the way it avoids sticking taxpayers or retirees with all the potential losses from a financial crash.

These adjustments are made automatically — no politician has to take a difficult vote to approve them. To smooth out the effects of up and down markets, the state spreads the gains and losses across five-year periods.

Other plans generally can’t take back their cost-of-living adjustments, even in down markets, because the entire pension is considered the retirees’ property.

After the global financial crisis raged in 2008 and 2009, Wisconsin retirees like Kratz saw their dividend payments dip by a total of more than $4 billion. In spite of that, Kratz still likes the state system.

“I think it’s fair and I think in the long run it’s going to work well,” said Kratz, a board member of the Wisconsin Coalition of Annuitants, which represents public retirees.

Over the past three years, improved financial markets have led the system to pay out $3.5 billion in additional pension benefits, helping retirees recover much of their losses without burdening taxpayers. These ups and downs also mean the system is closely watched by the pensioners, encouraging good governance.

“Because of the shared risk and reward … people have a stake in their benefit and they’re more interested in it,” said Bob Conlin, who now holds Gates’ job as the secretary of the Department of Employee Trust Funds.

A Swiss watch

Building Wisconsin’s system took a generation.

In the late 1940s, lawmakers first conceived of a well-managed statewide pension system to take over smaller funds, according to a research paper by the Legislature’s budget office. In 1951, Wisconsin became the first state in the country to allow public workers to participate in the federal Social Security program, a safety net not available to many public employees in Illinois.

A 1975 law folded together various funds for teachers, state workers and local employees, leaving out only the city and county of Milwaukee and a few minor funds. That made the state pension fund one of the biggest in the nation.

In the run-up to this merger, Max Sullivan, then the head of Wisconsin’s retirement system, and Gates, who was his deputy, conceived of the shared-risk model.

“Whether it was his idea or my idea or it came from both of our brains — I don’t think I know of any other place that did it like that. I think in a public system there was nothing like that,” Gates said.

The system was designed like a Swiss watch that winds itself, automatically adjusting for factors like how well the stock market does, how long retirees live, how long their surviving spouses collect checks, and so on.

The system helped hold down costs — a study released in March found that as of 2013, Wisconsin used 1.94% of its overall state spending to pay for its pensions, the fifth-lowest share in the country. State officials of both parties have largely paid in the money needed to keep the pension well-funded through the years.

It helped that the state Supreme Court rejected a 1987 attempt by then-Gov. Tommy Thompson and lawmakers to raid money from the fund, forcing them to pay $215 million to return the money with interest and pay attorney fees. If successful, the maneuver would have freed up more money in the state budget for other immediate priorities.

In 1999, lawmakers and Thompson, a Republican, approved a host of changes that increased future payouts from the pension system without increasing taxpayer contributions into it by the same degree. At the time, a soaring stock market made such moves seem possible financially. But a market crash soon followed, creating a financial hole for the pension system.

To strengthen the system, then-Gov. Jim Doyle, a Democrat, and Republican lawmakers decided in 2003 to essentially borrow money from Wall Street at a lower interest rate and then put that money into investments expected to yield a higher return. It was a risky strategy, but one that has so far paid off.

Gov. Scott Walker’s administration considered changing the state system once he took office in 2011, after running on a platform that included reducing public workers’ benefits.

Ultimately, Walker made no big changes to the pension plan other than requiring workers to pay more of the contributions to it. Instead, Walker chose to tout its financial strength during his short-lived run for president in 2015.

The reason was simple, said Conlin, who participated in the review as a top official in the Department of Employee Trust Funds.

“The loud and clear message was: We don’t have a crisis,” Conlin said.

Research for this project was paid for in part through a grant from the Ravitch Fiscal Reporting Program at the City University of New York. Officials at the program had no control over the reporting or presentation of this project.

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